Choosing a financial advisor is one of the most important decisions that you will make. The right advisor will contribute to your financial success, while a poor one can cost you money. With over 300,000 financial professionals in the United States, knowing how to choose a financial advisor can be challenging.
What makes choosing a financial advisor so challenging?
One of the biggest challenges is that there isn’t a consistent title for a financial advisor. We know what a brain surgeon does, but what is the difference between:
- Certified Financial Planner
- Wealth Advisor
- Investment Manager
- Or a Financial Advisor?
It’s all pretty confusing. While they may all seem similar, these titles and the folks who hold them might provide very different services. The titles don’t give us any insight as to what those services might be. We know exactly what a brain surgeon does, but there’s no legal standardization of titles and no clear definition that investors can hang their hat on.
So how do you begin to choose a financial advisor? There is a three-step process that will help you. Plus, there are seven questions that you should use in interviewing prospective advisors.
Three Steps to Choosing An Advisor
Step 1
The first step in seeking out an advisor is to write down exactly what you need to get from their services. What questions would you like them to answer? What are your biggest concerns that you’d like them to address?
For example, if you’re 10 to 15 years away from retirement, you may want to know if you’re retirement-ready. Do you have enough?
If you’re just a few years from retirement, you may just need someone to plan for the transition. Do you need help making a social security decision, Medicare or health care decision, or want some advice on the changes in taxes as you approach retirement?
If you are behind in your retirement savings you may be wondering, what’s the best savings vehicle for me? How can I best catch up?
All of these are different questions, and you want to find an advisor that answers these questions often!
Step 2
Once you decide what questions you’d like your planner to answer, you want to learn about the different types of financial advisors. Each advisor has a different service model and a different fee structure. Your specific needs and questions will determine the service model that’s best for you. For example, some advisors’ core service is doing planning work. They answer the question, “Do I have enough for retirement”? Some advisors’ models are investment-driven, whereas some advisors are insurance-driven. Match your questions above to an advisor whose service model will answer them.
This is then coupled with your personal preference for fee payment. Do you prefer to pay a fixed fee? Are you comfortable with a commission-driven compensation schedule? It’s best to find an advisor that operates under a service model that addresses what you need, as well as a pay structure that you’re comfortable with.
Step 3
Then finally, once you found a few advisors whose service model you are confident will answer your questions and a fee model you are comfortable with, the third step is to interview three or four advisors that fit what you’re looking for. They should be able to give you a detailed discussion of what their process looks like and how they can best help you reach your goals.
Getting ready for your advisor interview
Once you’ve identified three to four advisors that you would like to interview, what should that interview look like? Here are some questions you should ask your prospective advisor.
1. Are you a Fiduciary?
The first question to ask your prospective advisor is, are you a fiduciary? A fiduciary advisor is legally required to put your interest first. A fiduciary is also prohibited from selling you a financial product, an annuity, or a mutual fund, in return for commissions. Their compensation has to come directly from you, and they have to be transparent about it. It has to be a clear line item on their statement.
The second part of this question is, are you a fiduciary 100% of the time? Most of the time, this response will be no. Many advisors are what is called dually registered. When an advisor is dually registered, it means that they are a fiduciary during the advisory part of your work and other times they may not be. They may be delivering an insurance product or an investment product to you and getting compensated by commission or simple a proprietary product from their own firm. You can have fiduciaries who participate in these hybrid models, where part of their responsibility is fiduciary driven, but they are also licensed to receive commissions or hidden fees if they sell you products or represent investments and products from their firms. So the question is, are you a fiduciary, and are you a fiduciary 100% of the time?
2. What’s your specialty and how many clients do you work with?
The second question that you would ask is, what’s your specialty and how many clients do you work with? It’s critical to ask advisors what type of clients they specialize in working with because if you’re someone approaching retirement, you’d like to know that the advisor you are considering works with retiring clients all the time. You wouldn’t go to a personal injury attorney if you were looking for divorce advice, correct?
There are different specializations:
- Working with certain professions such as doctors, teachers, and optometrists.
- Specialize in a major corporation like Palantir or Amazon. They best understand benefits, compensation structures like options deferred compensation and can advise specifically to your employer
- Some advisors specialize in niches, like business owners or folks who are just approaching retirement. You should look for an advisor who specializes in your niche, your specific situation, because it’s comforting to know that they have worked with maybe 50, 60, or 70, people who look exactly like you.
You also want to ask, how many clients do you serve? An experienced lead advisor can serve about 100 clients while still giving them an appropriate amount of time. If you have an advisor who says they have 300 clients, you might not get the time and attention that you might need to address your issues.
You can also ask them about their service model, what exactly does it look like? Ask them about their fee structure, team headcount, and who supports them. This will give you an indication of the number of clients that they can service.
3. What is the total cost to work with you?
The third question that you want to ask an advisor is, what’s the total cost to work with you? Just because the financial advisor is a fiduciary, doesn’t necessarily mean that there aren’t costs. There are some common fees you might pay when working with a fiduciary:
- Fixed fee for advice. This can be an hourly fee, a project based fee, a percentage of your assets under management.
- Transaction costs associated with the work that they’re going to do for you. There can be transaction costs for buying and selling mutual funds, stocks, or exchange-traded funds charged by their custodian. No matter who the custodian is, you want to know upfront if there are any transaction fees when they are managing your money.
- Internal expenses for your ETFs or mutual funds that you use in your portfolios. Investment companies charge expenses to manage their funds, and they factor these expenses into the total cost of working with an advisor. As a fiduciary advisor, they should focus on very low-cost exchange-traded funds.
4. What’s your experience with complex financial planning issues?
The fourth question you might ask your prospective financial advisor is, what’s your experience with complex financial planning issues? For example, an experienced advisor working with retirees should have worked quite often with reducing taxes in retirement. This includes everything from avoiding the surcharges associated with Medicare to understanding how to minimize the taxes associated with your Social Security, your other earnings, and Roth conversions. They should create tax-efficient retirement income, increase tax deductions through charitable giving, and lower portfolio risk while optimizing investment returns. Your advisor should understand healthcare and the insurance needed in retirement and help any prospective retiree transition into retirement.
5. What processes do you use?
Your advisor should be able to tell you in detail how they gather data, how they analyze that data, how they will analyze your unique situation, and what software or proprietary methods do they use to arrive at their recommendations to you. How they’re going to implement your plan and how they’re going to monitor it on an ongoing basis?
6. Where will you hold my money?
If they’re managing your investments, where will they hold your accounts? You want to make sure that they’re using a reputable third party such as Fidelity, Pershing, Schwab, or Vanguard. Knowing where your money is will bring you peace of mind.
7. What is your investment philosophy?
Finally what is your investment philosophy? While investments are just one aspect of financial planning, it is critical to ask a financial advisor about their investment philosophy if they’re managing your investments. Do they invest in exchange-traded funds? Are mutual funds part of their strategy? Do they offer individual stocks, or if you’d prefer to keep your individual stocks, are they open to that approach? Are they using alternative investments? If you’re still working, will they integrate your 401K savings? Do they have a process for tax loss harvesting, and do they have a process for tax gain harvesting? These are important questions that they should be able to answer regarding your investment management.
The bottom line is that choosing a financial advisor is one of the most important decisions you will make. Working with the right advisor for your unique situation can mean the difference between a carefree retirement and a stressful one. Don’t be afraid to ask the tough questions when meeting an advisor. Like any other professional, they are there to serve the needs of their clients, and a good advisor will welcome all of your questions.